| ||Tax Benefits, Tax Administration, and Legislative Intent |
David P. Hariton*
* Partner, Sullivan & Cromwell, New York, N.Y. This Article was first presented to the Tax Forum on March 6, 2000 (Tax Forum No. 540).
This Article examines various tax benefits that are associated with the ownership of financial assets, why Congress granted them, why Congress limited their availability under certain circumstances, and how, in light of the answers to these questions, the relevant statutes should be administered by practitioners, the Service, the Treasury, and the courts.
Now there are two kinds of tax benefits that travel with financial assets. The first is intended to encourage specified investment behavior ( e.g., investment in business, low-income housing, or public facilities). Taxpayers abuse this kind of benefit when they obtain the benefit in the absence of the investment behavior that Congress sought to encourage. The second kind of benefit is designed to exempt specific persons or entities from taxation under specific circumstances ( e.g., the dividends received deduction, the foreign tax credit, and the treatment of exempt organizations). Taxpayers abuse this kind of benefit when they obtain the benefit in the absence of the specified circumstances.
The availability of the first kind of benefit is limited by the amount of targeted investment behavior. Taxpayers can therefore be permitted and expected to use free market transactions to pass the benefit to those taxpayers that are most advantaged by it. In other words, taxpayers will not, acting as a whole, effectively decline part of a proffered benefit. But Congress presumably does not want them to decline part of the benefit, because that would result in less than maximal encouragement of the targeted investment behavior. Congress presumably granted the benefit assuming that it would be used to the maximum extent.
Taxpayers cannot be permitted, however, to claim tax benefits for non-targeted investment behaviors, such as accelerated depreciation for investment outside the United States. Likewise, taxpayers cannot be permitted to duplicate tax benefits without increasing targeted investment behavior by entering into transactions that permit more than one taxpayer to claim ownership of the relevant tax-advantaged asset.
The availability of the second kind of tax benefit is not limited by the supply of targeted investment behavior but rather by the frequency of exempt activity ( i.e., it is virtually unlimited). Congressional intent can therefore be frustrated when a non-privileged taxpayer that owns specified assets as an economic matter (because such ownership has meaningful economic consequences to that taxpayer) uses a financial transaction to attribute technical ownership to another taxpayer, who then claims the relevant tax benefits. Such attribution does not serve to transfer congressionally-sanctioned tax benefits from one taxpayer to another, but rather to create tax benefits that would not otherwise exist. Congress did not intend, for example, to grant a deduction for every dividend received in the United States. Rather, it intended to partially exempt dividends received by corporate shareholders to limit multiple taxation of earnings at the corporate level. It is therefore reasonable for Congress and the Treasury to promulgate rules to prevent corporations from claiming technical ownership of dividend-paying stock that is owned by non-corporate taxpayers as an economic matter.
To analyze the efficacy of such rules, however, as well as to develop and administer them properly, one must know what Congress was trying to exempt and why. Unfortunately, Congress’s intent is not always clear. We shall consider, in this regard, the purported use of leverage and derivative contracts to create or duplicate unintended tax benefits arising from investment in corporate equity at both the shareholder and corporate levels, and in both domestic and cross-border contexts.
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